Floating Yuan: Change China's Way

James M. Borneman, Editor In Chief

C hina's change in the management of its currency, the yuan, took many by surprise after
years of prodding by groups adversely affected by mounting Chinese imports.

At first blush, the change - linking the yuan to a basket of currencies rather than riding
it lock-step with the dollar - seems like an answered prayer.

But rather than the 15- to 30-percent adjustment many economists hoped for, the yuan was
adjusted just 2 percent. Details of its future ability to adjust remain sketchy at best. As of this
writing, the basket of currencies' makeup and weighting are undefined, and the yuan's daily float
is extremely limited.

Stability is key in China. Considering Chinese banks and the financial system have
additional reforms yet to accomplish, the shift in currency policy is a step - albeit a small step
- in moving to a market-based economy. As minor as this adjustment seems, it does establish a
change - and from the Chinese perspective, a change that will be predictable and controllable - two
parameters that aid stability.

Is it too little, too late? Maybe. Many economists state that adjustments of less than 10
percent will have little effect on trade issues. And don't forget Chinese pricing power. Although
many Chinese producers complain of thin margins and growing wage pressures and shortages, their
ability to sell below cost has been alleged over and over.

If a strengthening yuan raises import prices, retailers may slow their rush to China.
Factors such as proximity, speed to market and safeguard risks may become more important.

If the currency basket China chooses includes the euro, pound and US dollar, as well as
other Asian currencies, there is a chance the Chinese will have to buy those currencies with
greater frequency to manage the basket. That demand will affect the US dollar's value against those
currencies - basically creating more demand for foreign currencies. Some predict changing demand
for US bonds will lead to rising interest rates; some, to higher consumer prices; some, to
increased US exports beyond China; and many point to a weaker dollar.

If you are a pessimist, start worrying now. A stronger Chinese currency means the US dollar
reserves in China still buy their face value of US assets, and a stronger yuan increases Chinese
purchasing power. The time for China to dive into ownership of US-based companies may be
accelerating beyond interest in oil and commodities. US brands, retailers and high tech might be
the ticket for China to jump past being just the world's manufacturing floor and allow it to
establish a broader stance in the global economy.

It seems everything in China happens on China's schedule - not sooner, nor under pressure
from anyone else. That said, one hopes the reaction to this shift in currency policy is taken
seriously, but also with a grain of salt. Don't whine or cheer too loudly; rather, understand that
China is in this for the long haul and sees the United States' short policy horizon as an
opportunity. The United States needs to understand the strategic mindset of China, based more in
engineering than in law, and act accordingly. China has a plan. Do we?